It is now widely expected that Union Finance Minister Pranab Mukherjee will seek to get a grip on fiscal consolidation. How he does this will impact on his and India’s credibility. His aim has to be not to lose revenues on the reforms roundabout that he gains on the growth swing. Although macroeconomic authorities remain optimistic about growth, some economic indicators (growth in the Index of Industrial Production for November and December 2010 were in low single digits) seem to point to a slowing down of the economy. Inflation is also likely to taper off over the year if the impact of tight monetary policy begins to work itself through the system. Both these trends will adversely affect revenue collection, particularly indirect taxes, since they imply slower nominal GDP growth. Besides, the current fiscal year produced a bonanza for the exchequer in the form of 3G spectrum auction receipts that exceeded the Budget estimate by over Rs 70,000 crore. It is unlikely that there will be a similar windfall in the next fiscal year.
On the expenditure side of the fiscal balance, high commodity prices could pressure the subsidy bill, both for petroleum products and food (if imports have to bridge the demand-supply gap). Provisions will have to be made for legislation such as the right to food and this is likely to bloat the subsidy tab further. Then there are the allocations due for the National Rural Employment Guarantee Scheme and infrastructure schemes — the list is endless. Despite these compulsions, the finance minister will have to find ways to reduce the revenue-expenditure gap. One option is to prune the myriad programmes that get budgetary support from the Centre and use the funds released from this for flagship schemes like the National Rural Employment Guarantee Scheme. The other option is to raise the excise duty to 12 per cent. However, it is important to ensure this rate dovetails with the structure of the much awaited and much delayed goods and services tax (GST). Raising revenues from such tax reform should be an objective of the budgetary policy this year.
Of course, the finance minister may get a cushion from the recently revised GDP series (that uses a new price deflator) with the denominator now uniformly higher than in the earlier series on which initial Budget estimates were made. This, following simple arithmetic, is likely to pull ratios like the fiscal deficit-to-GDP down. Thus, it is possible that the fiscal deficit-to-GDP ratio for 2010-11 will print at five per cent instead of 5.5 per cent. It is important that the finance minister does not rely on this artifice alone to achieve fiscal consolidation that he has committed to. In specifying a long-term fiscal path, he has set a fiscal deficit target of 4.8 per cent for 2011-12 (this is, incidentally, also the level that the Finance Commission had recommended). This was based on the older GDP series. For the deficit target to imply meaningful consolidation using the revised series, it should be set at least half a percentage point lower for 2011-12. Tax reform can be a more lasting instrument of fiscal consolidation.
